Nearly 400 former employees, of a workforce that in March topped 2,000, have joined a social network clamoring to get their unpaid wages. Zhang, who gave only his family name, is one of fewer than three dozen workers left at a company that last year was worth 2 billion yuan ($312 million).

“We just wanted to build the market, so we burned through our money,” he said, adding he hasn’t seen the firm’s CEO since March.

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In China’s hottest tech sector, hundreds of “online to offline” (O2O) start-ups like Shequ001, which draw mobile users to local physical stores and services, have failed as skyrocketing valuations deter investors and put the brakes on fresh funding. Many more are expected to fall by the wayside, or be driven into mergers in what executives and investors say is a market bubble.

Lured by a potential 10 trillion yuan ($1.57 trillion) market for app-based, on-demand, logistics-heavy businesses, venture capitalists and others piled in, throwing billions of dollars at firms that often need only cash and a working app to enter the fray.

China now boasts 21 ‘unicorns’ – private start-ups valued at over $1 billion – says CB Insights. But now, those inflated valuations – for companies that rarely make any money – are proving too much for investors and new funding is drying up.

Investors who helped fund the O2O sector now warn of a bubble, fueled in part by backers’ own willingness to keep handing over cash. Having spent billions on their chosen champions, some are unwilling to admit defeat, signaling a war of attrition in the hope of backing the next Facebook or Alibaba.

“The number of ‘unicorpses’ will soon begin to catch up with the number of unicorns,” said Gary Rieschel, Shanghai-based founder and managing director of Qiming Venture Partners.

O2O has found particular traction in China through a combination of widespread smartphone use, a booming mobile payment sector and cheap migrant labor.

Entrepreneurs developing O2O apps – for firms offering anything from ride hailing and food delivery to group discounts at shops, restaurants and cinemas – have had easy access to money from technology giants Baidu, Alibaba and Tencent, as well as from venture capitalists, private equity, sovereign wealth funds and state-owned enterprises.

Start-ups backed by venture capital raised $9.6 billion in July-September alone, four times the level of a year earlier, according to a KPMG and CB Insights report.

“The whole O2O concept is getting too expensive,” said Han Weiwen, head of Bain & Co’s private equity practice in China. “The valuation is very, very high. There’s no traditional way to look at the valuation … because they don’t have revenue.”

“ARMS RACE”

Driven by China’s competitive ferocity, companies such as Didi Kuaidi, Uber, Meituan-Dianping, Nuomi and Ele.me battle each other across multiple sectors, often armed with seemingly endless cash from their big technology backers.

“It’s an arms race,” said Hurst Lin, co-founder and general partner of DCM Ventures.

The fierce competition and high spending drives start-ups back to their investors for frequent cash injections, pushing valuations higher.

But as the financing roller-coaster has slowed, many start-ups have struggled to afford the subsidized discounts they need to keep users. In O2O, user numbers, whether from inflated demand or not, are a key metric to attracting fresh investment.

“This kind of craziness can’t go on forever,” said Liu Jun, who heads Baidu’s efforts in O2O and sits on the board of Uber’s China unit. “Enough is enough.”

“IRRATIONAL MARKET”

“O2O is an irrational market,” said Liu Bo, formerly head of human resources at Koala Bus, an on-demand bus service acquired by ride hailing firm Didi Kuaidi. “There are too many subsidies. It’s becoming more expensive to get new customers.”

Some companies, like Didi Kuaidi, Uber and Ele.me, say they have either ended or are reducing subsidies – but that risks killing off demand, and that’s not just a Chinese phenomenon.

In July, Homejoy, a U.S. start-up offering house cleaning services through mobile apps, folded, leaving some top-tier private equity backers out the $35 million or so they had sunk into the company. With a minimum hourly rate of $25, Homejoy offered an initial 2.5-hour house cleaning for just $19, leading to too many one-time-only customers.

A spokesman for Didi, though, says it has matured from a growth-driven firm to one that can now focus on innovating and improving user experience for its platform of 250 million registered users, and some 10 million registered drivers.

“CRAZY HOT TO INSANELY COLD”

The slowing pace of investment has left many start-ups unable to support themselves and struggling to find fresh funding.

“In the first half of the year, the market was crazy hot, but in the second half it’s been insanely cold,” Lei Jun, a high-profile investor and CEO of private smartphone maker Xiaomi Inc [XTC.UL], itself valued at $46 billion, told a technology conference in October. “There are some very depressed start-up founders.”

Some investors note that start-ups and their backers are happy to see valuations inflate.

One venture capitalist, who declined to be named, said: “My peers, most of them are saying: ‘Get big, get a lot of users and figure out how to monetize later, that’s for the later-stage guys’.”

“And the later-stage guys are saying: ‘You still don’t need to be profitable, that’s for the public investors, the mutual funds, or the mom and pops when they buy (the stock). That’s for them to figure out’.”

For some start-ups, consolidation is the answer.

Didi Kuaidi and Meituan-Dianping were both formed after investors tired of the cost of companies – in each case with one side backed by Tencent and the other by Alibaba – competing against one another. Alibaba is looking to offload its Meituan-Dianping stake, not so much to cash in on lofty valuations but to focus on its own in-house contender, Koubei.

Investors will push their firms to consolidate until one company dominates, said Jixun Foo, managing partner at GGV Capital. “The market will go through a phase of consolidation to figure out if, through that, they will ever make money.”

Baidu’s Liu Jun, DCM’s Lin and others say the O2O sector has the makings of the dot.com bubble that burst in 2000, and some expect investors to write down what could amount to big losses.

“(When) raising capital gets harder, then you find out who’s naked, and who doesn’t really have a business model,” said Qiming’s Rieschel.

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